Author: Andrew Turner

Andrew Turner, Chairman of Commercial Trust, gives his view on governmental interference in the housing market and the future for private investment in the sector.

In August 2012, a report entitled 'Review of the barriers to institutional investment in private rented homes', by Sir Adrian Montague, set the agenda for a corporatized private rented sector that attracts institutional investment through the promise of "acceptable, secure returns".

Fast-forward three and a half years, and the government is finally affecting that transition – at the expense, it seems, of small individual investors.

New tax measures to penalise landlords

All landlords should by now be familiar with the government's plan to withdraw buy to let mortgage interest relief for landlords, which the Chancellor announced during last year's Summer Budget.

www.gov.uk/government/publications/restricting-finance-cost-relief-for-individual-landlords

Landlords should also be familiar with the 3% surcharge that will be levied on the purchase of additional properties (i.e. second homes and most buy to lets) from 1 April, which was unveiled during the Autumn Statement in November 2015.

Buy to let 2 (PD)

The government claims the measures will help home buyers

The stamp duty surcharge, the Treasury claims, will "[support] families buying their own home". The relief withdrawal, meanwhile, will limit "the advantage that [landlords] currently enjoy" over owner-occupiers.

According to the Guardian, the measures might be working; the availability of two-bed homes is at a nine-year high, suggesting that some landlords are selling up.

But the problem for home buyers is not just the availability of housing. As analysis has shown, many families are locked out of the housing market by affordability. Increasing availability may go some way towards correcting prices – but is this really the Chancellor's aim?

The government does not want house prices to fall

House prices would have to fall to a significant degree if they were to become affordable for the average buyer.

Neither the government nor the Bank of England wants this. In fact, in its December 2015 Financial Stability Report, the Bank of England warns that a fall in property prices could "impact … consumer spending and economic stability".

How are house prices tied to economic performance?

There is evidence that consumer spending and house prices are linked. Much of this has to do with the 'wealth effect' – the rise or fall in perceived wealth in line with the value of an owned asset, such as a property.

Research has also shown a link between household debt and consumer spending. Economic 'booms' are frequently preceded by growing levels of debt, and crashes are followed by a reduction in both debt and spending.

To understand the relationship between economic performance and house prices fully, we also need to consider credit loss incurred by lenders when they foreclose on mortgages during a period of falling house prices. Higher levels of credit loss can affect credit availability.

Therefore, when house prices fall, two things can be said to occur:

• Households spend less as their perceived wealth decreases

• Households borrow less as banks are less able to lend, further affecting consumer spending

This can adversely affect economic growth, and if the problem is acute and protracted enough, it may run the risk of pushing the economy into recession.

Market fundamentals need to remain relatively stable

I believe that the government is taking a gamble here. For the reasons discussed, deterring buy to let investment to the extent where house prices drop appreciably would be economically hazardous; it therefore stands to reason that policymakers have ulterior motives beyond simply penalising landlords to help buyers.

The degree of leverage in the buy to let sector is perceived, both by the government and the Bank of England, as too high, and a further risk to economic stability (Bank of England: Financial Stability Report July 2015). It therefore seems highly likely that the government seeks to prompt a slow transition from a predominantly privately-run rental sector to an institutional sector.

For this, as Sir Montague observed the rental sector must promise good returns. Therefore, either rental returns need to be high, prices need to be rising, or both.

The ratio of supply and demand therefore needs to remain stable, exerting enough upward pressure on prices to encourage above-inflation appreciation; only corporate investors, rather than owner-occupiers, will fill the gap left by the private investors who are exiting the market.

Limited companies are largely exempt from the tax changes

The new finance cost relief restriction will affect only individuals and entities who pay income tax; those who pay corporation tax, such as limited companies, will be able to offset mortgage interest as before.

In addition, there are a number of proposed exemptions to the stamp duty surcharge for larger investors, the majority of which are likely to be institutional investors. Examples include an exemption for bulk purchases of 15 properties or more, and 'multiple dwellings relief' (MDR) for bulk purchases of 6 properties or more.

For larger private investors, the extra stamp duty cost at purchase is arguably negligible if the investment stacks up (and can be offset against capital gains at disposal). Similarly, larger private landlords are better able to meet incorporation costs if they so choose, or alternatively can incorporate for future purchases in order to reduce leverage outside of the company. Only smaller private investors are penalised by the changes.

So what is the future for smaller buy to let investors?

Prospective entrants to the market, and landlords with smaller portfolios, could be forgiven for thinking now is a bad time to expand or invest.

But by researching the investment thoroughly, tailoring an approach that best suits your own goals and stress-testing your model to ensure that it remains resilient against shifting markets and changing policy, it is still quite possible to reap the rewards of a sector that remains strong while global financial markets flounder.

This might involve looking to areas with lower entry costs, higher yields and better growth potential. The best route varies from investor to investor – but whatever the case, succeeding in buy to let takes a lot of forethought and work. It is most certainly not easy money!

Take a professional approach. Seek appropriate advice from accountancy, finance and tax advisors. And remember that the short- to medium-term volatility of property is generally tempered by long-term growth, so take the long view if you are just starting out.

The ideal housing market would cater to the UK with a healthy choice of affordable housing across all tenures. Private landlords who treat their investment like a business and adapt to change have the best chance of helping to deliver this.

Written by Andrew Turner at www.commercialtrust.co.uk

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